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June 02, 2001 at 08:00 PM
W e are in a market well down from its highs. As investors and professionals, what should we be doing ourselves and telling our clients to do? Let’s use the S&P 500 as a measurement.
The S&P has had seven large declines since its inception in 1957, not including the present one. The average pullback has been 30.5%. Down-legs can be lengthy, with some lasting as long as 21 months.
So if history is any guide (and often with the markets it is not), with the S&P having gone down 30% and now down about 18% there is a strong case for buying stocks, particularly from a value and bargain-hunting basis.
As for valuations, this newly sober market is turning again to P/E ratios. The P/E multiple on the S&P 500 is now about 25. Since 1967, the average multiple on the index is 16. So one could say the index is still rich, overvalued by about 30%.
But the S&P 500 is not what it once was, and is entitled to a richer valuation. Technology–which comprises a much bigger part of the index, about 19%–has a higher multiple than most others. So now the S&P 500 is more growth oriented, which creates a higher multiple.
Technical analysis also suggests the bottom may not be that far off. Markets often retrace to the high of the previous bull market, the point before that bull entered a bear phase. In other words, the market gives back all of the advances of a bull market run, but finds support in the prior bull market’s high point.
If you draw a line on the S&P 500 chart, connecting the start of this bull market in 1982 through its end in 1998, it appears that the index would have to retrace back to about 950-975 to meet that long-term trend line. Although that possibility is rather dire, the index is not that far off now, standing at 1266.
The market could go lower, and the next upward cycle could take years to develop. But the time to buy–the time of best value–is when the markets are down and people don’t want to buy stocks.
